Tag Archives: price to tangible book value

It’s been a while since I posted on the specialty insurance sector and I hope to post some more detailed thoughts and analysis when I get the time in the coming months. M&A activity has picked up recently with the XL/AXA and AIG/Validus deals being the latest examples of big insurers bulking up through M&A. Deloitte has an interesting report out on some of the factors behind the increased activity. The graph below shows the trend of the average price to book M&A multiples for P&C insurers.

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As regular readers will know, my preferred metric is price to tangible book value and the exhibit below shows that the multiples on recent deals are increasing and well above the standard multiple around 1.5X. That said, the prices are not as high as the silly prices of above 2X paid by Japanese insurers in 2015. Not yet anyway!

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Unless there are major synergies, either on the operating side or on the capital side (which seems to be AXA’s justification for the near 2X multiple on the XL deal), I just can’t see how a 2X multiple is justified in a mature sector. Assuming these firms can earn a 10% return on tangible assets over multiple cycles, a 2X multiple equates to 20X earnings!

In a previous post, I compared the M&A action in the reinsurance and specialty insurance space to a rush for the bowl of keys in a swingers party. Well, the ACE/Chubb deal has brought the party to a new level where anything seems possible. The only rule now seems to be a size restriction to avoid a G-SIFI label (although MetLife and certain US stakeholders are fighting to water down those proposals for insurers).

I expanded the number of insurers in my pool for an update of the tangible book multiples (see previous post from December) as per the graphic below. As always, these figures come with a health warning in that care needs to be taken when comparing US, European and UK firms due to the differing accounting treatment (for example I have kept the present value of future profits as a tangible item). I estimated the 2015 ROE based upon Q1 results and my view of the current market for the 2011 to 2015 average.

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I am not knowledgeable enough to speculate on who may be the most likely next couplings (for what its worth, regular readers will know I think Lancashire will be a target at some stage). This article outlines who Eamonn Flanagan at Shore Capital thinks is next, with Amlin being his top pick. What is clear is that the valuation of many players is primarily based upon their M&A potential rather than the underlying operating results given pricing in the market. Reinsurance pricing seems to have stabilised although I suspect policy terms & conditions remains an area of concern. On the commercial insurance side, reports from market participants like Lockton (see here) and Towers Watson (see graph below) show an ever competitive market.

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Experience has thought me that pricing is the key to future results for insurers and, although the market is much more disciplined than the late 1990s, I think many will be lucky to produce double-digit ROEs in the near term on an accident year basis (beware those dipping too much into the reserve pot!).

I am also nervous about the amount of unrealised gains which are inflating book values that may reverse when interest rates rise. For example, unrealised gains make up 8%, 13% and 18% of the Hartford, Zurich, and Swiss Re’s book value respectively as at Q1. So investing primarily to pick up an M&A premium seems like a mugs game to me in the current market.

M&A obviously brings considerable execution risk which may result in one plus one not equalling two. Accepting that the financial crisis hit the big guys like AIG and Hartford pretty hard, the graph below suggests that being too big may not be beautiful where average ROE (and by extension, market valuation) is the metric for beauty.

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In fact, the graph above suggests that the $15-$25 billion range in terms of premiums may be the sweet spot for ROE. Staying as a specialist in the $2-7 billion premium range may have worked in the past but, I suspect, will be harder to replicate in the future.

It has been a while since I looked at net tangible asset multiples for reinsurers and selected specialty insurers (the last such post is here). Motivated by the collapse in Lancashire’s multiple (briefly mentioned in a previous post) since they went ex-dividend, I redid the tangible book multiple figures. Previously I have used average operating ROEs as the x-axis but this time I have used annualized total returns since year-end 2010 (to capture the 2011 catastrophe year with the recent results of the past 3 years). Annualized total returns are made up of tangible book growth and dividends paid in 2011 to today. The split between tangible book growth and dividends, on an annualized basis across the past 4 years, for each firm as per the graph below (when calculating tangible book values, as is my usual practise disclosed previously, I excluded all goodwill and intangibles, except for the present value of future profits (PVFP) for life reinsurance business for European reinsurers).

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The graph of tangible book multiples to annualized returns is below. [Note – although insurance accounting has converged somewhat in recent years, caution still needs to be taken when comparing UK, European, and Bermudian/US firms due to the differing accounting regimes under which results are reported].

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I split the firms into different colours – green is for the Bermudian & US firms, red is for London market firms, and blue is for the European composite reinsurers. In terms of who else may get involved in M&A following the Renaissance/Platinum deal, its interesting to see most of the Bermudians bunched up so close to each other in valuation and return profiles. The higher valued and larger firms may be the instigators in taking over smaller competitors but it looks more likely that medium sized firms need to get with today’s realities and seek tie-ups together. Who will wait it out in the hope of some market changing event or who will get it together in 2015 will be fascinating to watch!!

Follow-on: To get an idea of historical changes in the tangible book multiples in the three groupings above, the graph below shows the trends. The multiples in each year are simple averages across the firms (and not all are at the same point in the year) but the graph nonetheless gives an idea of changing market sentiment. Although the London and European firms are a smaller sample than the Bermudian/US firms, the graph indicates that the market is confident that the underwriting indiscipline of years past have been overcome in the London market, thus justifying a premium multiple. Time will tell on that score…..

Likely proving that a little knowledge is a dangerous thing, I was looking over the insurance tangible book value (TBV) multiples that I monitor and it stuck me that the S shaped curve from prospect theory may be more suitable than a linear fit. As I say, I am likely adding one and one and getting three!

The TBV multiples have continued to expand in 2013 as the graph below shows (market values as of the date shown against the tangible book value from the preceding quarter).

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For the market values as of today against Q3 2013 tangible book value, I fitted a S curve as below.

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I am aware that the S curve is the wrong way around compared to one in the previous post but that could be rectified by flipping the axis. As I said, I haven’t really thought it through in detail but thought it was interesting all the same!

With that, I’d like to wish everybody a great Christmas and a peaceful 2014. Many thanks for your interest in my ramblings through 2013.

As it has been almost 6 months until my last post on the tangible book value multiples for selected reinsurers and specialty insurers I thought it was an opportune time to post an update, as per graph the below.

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I tend to focus on tangible book value as I believe it is the most appropriate metric for equity investors. Many insurers have sub-debt or hybrid instruments that is treated as equity for solvency purposes. Although these additional buffers are a comfort to regulators, they do little for equity investors in distress.

In general, I discount intangible items as I believe they are the first thing that gets written off when a business gets into trouble. The only intangible item that I included in the calculations above is the present value of future profits (PVFP) for acquired life blocks of business. Although this item is highly interest rate sensitive and may be subject to write downs if the underlying life business deteriorates, I think they do have some value. Whether its 100% of the item is something to consider. Under Solvency II, PVFP will be treated as capital (although the tiering of the item has been the subject of debate). Some firms, particularly the European composite reinsurers, have a material amount (e.g. for Swiss Re PVFP makes up 12% of shareholders equity).

Disclaimer

This blog represents my personal views and is not reflective of the views or opinions held by any company or employer I work for currently or have worked for in the past. The views expressed herein are based solely upon publicly available data. No views expressed herein should be taken as an endorsement to take any particular course of action in the markets. The basis of this blog is that different views should be expressed and readers make up their own minds on the what they believe and act accordingly.